Lessons from the dot com implosion and the financial meltdown.
Henry Kissinger once observed that while history does not repeat itself it often offers useful lessons regarding the future. With this in mind, I thought might be useful to see what lessons the last two periods of economic adversity – the dot com implosion and the financial meltdown — might offer in terms of where the market for legal services might go in light of the coronavirus calamity.
The short answer is “plenty.” Necessity is the mother of invention and driving change is much easier in times of adversity than times of plenty. The years following both the dot com implosion and the financial meltdown showed significant changes in the market for legal services. Logic dictates that the even greater adversity of the coronavirus calamity will produce and even greater wave of change.
The Dot Com Implosion – 2000-2002
By today’s standards, the dot com implosion and the associated global recession of the early 2000s were fairly minor events. The actual recession in the U.S. lasted for approximately 10 months in 2001, and the economy actually grew slightly over the entire year, then accelerated over the next two years. See Time Series US GDP, World Bank (1987-2018). Similarly, U.S. unemployment peaked at 5.8% in 2003 and then fell steadily until the next recession. See Time Series of US Unemployment, Multpl.com (1948-2020). Overall, the recession was a relatively mild one with a solid V-shaped recovery.
The overall picture, however, only tells part of the story. While mild overall, this recession heavily impacted certain sectors of the economy, especially tech. By the end of the stock market downturn in 2002, the NASDAQ had fallen almost 80% from its peak, with tech companies losing a collect $5 Trillion in market cap, and many going out of business entirely. See Times Series of NASDAQ, FRED Economic Data (1990-2020).
When the NASDAQ began its free fall in the latter part of 2000, reactions among tech companies were rapid and followed a pattern seen again in the financial meltdown. Companies immediately looked to conserve cash, imposing strict cost controls and reducing the size of their workforces. Law departments were not immune to these changes, including layoffs, and had to start doing more with less. They responded by looking at their biggest cost drivers (typically outside counsel spend and internal headcount) and looking for alternative solutions. The natural resistance to change broke down as in-house lawyers realized that their only options were to do things differently or work truly unsustainable hours.
The pressure for change actually increased as the economy started to rebound. Companies were uncertain about whether any uptick was a blip or the start of something big. Their balance sheets were weakened by the worst of the crisis and their capacity to invest remained diminished. Accordingly, the cost controls stayed in place and the scaled back law departments now had a growing volume of work to handle.
These pressures helped spawn a variety of innovations in the law departments at tech companies and elsewhere, establishing a foundation for even greater innovation during the next downturn. Much of this innovation started with employing operational methodologies such as Six Sigma and Lean to standardize the delivery of volume legal services with tasks being disaggregated and assigned to the most efficient provider. These same techniques were used to start monitoring outside vendors’ bills (namely law firms’). Where tasks could not be automated, law departments started turning to non-traditional legal service providers – namely Indian LPOs – for help. This, in turn, enabled these vendors to move up market from performing litigation document reviews into handling a wider variety of volume legal work, including contracts, compliance, and M&A due diligence.
The impact of these changes shows up clearly in the employment statistics. Between 2000 and 2004, employment in non-traditional legal service providers grew at over three times the rate of employment in law firms.
The Financial Meltdown — 2007-2009
The financial meltdown and its resulting recession were both broader and deeper than the dot com implosion. GDP in the U.S. contracted significantly in both 2008 and 2009, see Time Series of US GDP, World Bank (1988-2018), with U.S. unemployment peaking at 9.8% in 2010. See US Unemployment by Year, Multpl.com (1948-2020). Unlike the dot com implosion, this recession touched virtually all sectors of the economy in a meaningful fashion.
Businesses and law departments responded to this recession in much the same fashion as the tech companies did in the dot com implosion, cutting costs to conserve cash. Once again, law departments were asked to do more with less, with the pressure reaching its maximum when the economy was on its way back.
This time, however, the greater depth of the recession and the breadth of companies impacted triggered a wave of innovation of unprecedented magnitude. The innovations flowing from the prior recession became mainstream and were extended exponentially across virtually all geographies and all industries. For example:
- Offshore outsourcing of virtually all kinds of volume legal work became common place, with India now seeing significant competition from near-shore locations (e.g., Belfast, Phoenix), Eastern Europe, South Africa, Manila, etc.
- Multiple countries and even the ABA liberalized regulations of the legal sector to allow for additional competition and to remove barriers to innovation (e.g., restrictions on taking capital from non-lawyers)
- CLOC was formed in 2010, quickly becoming an international organization with hundreds of corporate members, in tens of countries, controlling hundreds of millions, if not billions, of dollars of legal spend. Indeed, a significant percentage of CLOCs founders came from tech companies (NetApp, Cisco, Google, Adobe, Flex, etc.) and were veterans of the first wave of innovation.
- Legal tech companies flourished with many achieving billion dollar valuations
Once again, these changes came at the expense of the status quo. Between 2007 and 2010, employment in law firms declined while employment in the non-traditional sectors grew by ~80%.
The Coronavirus Calamity – 2020 – ?
Nobody knows what the economic impacts of the coronavirus ultimately will prove to be. That said, the fundamental nature of this event almost guarantees that the resulting downturn will dwarf either of the prior two recessions. This crisis is fundamentally a health crisis and one cannot expect the economy to start to recover until the virus is brought under control, either because we develop a vaccine or attain herd immunity. Even the most optimistic predictions from credible sources indicate that this will not occur for at least a year if not longer. The graphic to the right offers four scenarios for recovery, with only three that are plausible and the Y-shaped recovery being the most optimistic.
With a typical V-shaped recovery of the table, our economy will be severely impacted. Currently, approximately 95% of Americans are subject to stay at home orders and most businesses are either closed or being operated remotely. See Holly Secon & Aylin Woodward, “95% of Americans have been ordered to stay at home,” Business Insider, Apr 7, 2020. Similar conditions exist around the globe. Over 10 million Americans applied for unemployment during the last two weeks, shattering previous numbers. Morgan Stanley now predicts that the economy will contract in Q2 2020 at an annualized rate of 30% — over ten times the contraction experienced in 2009, the worst year of the financial meltdown. See Jim Tankersley, et al., “Trump Considers Reopening Economy, Over Health Experts’ Objections,” NY Times, Mar 23, 2020. Nobel-prize winning economist Joseph Stiglitz predicts that unemployment could reach 20% or higher, more than double the peak of the financial meltdown. Sara Silverstein, “Joseph Stiglitz says US unemployment could reach 30% before the coronavirus outbreak wanes,” Business Insider, Mar 27, 2020.
Unfortunately, simply solving the health issue may not be enough, alone, to bring the economy back. Both companies and consumers are likely to suffer significant hits to their balance sheets while dealing with the virus and its associated closures. In particular, Stiglitz, among others, predicts that the impact on the middle and lower classes will be particularly great. See Silverstein, supra (interview of Stiglitz). Until consumers have the means to purchase and companies have the means to produce, the economy is unlikely to return to full steam.
For all of these reasons, it seems like a no-brainer to say that the depth and breadth of this recession will greatly exceed that of the financial meltdown.
Looking at history, one would expect to see the same sorts of reactions from companies and law departments that we saw in the dot com implosion and the financial meltdown. This will start with cost cutting (including layoffs) to help preserve cash. This, in turn, will put pressure on law departments to do more with less, with that pressure intensifying when the economy starts to turn around. As in the past, this pressure is likely to spur another wave of innovation.
What is likely to change
It seems easy to predict that this next wave of innovation will both build upon the innovation spawned by the prior two events and trigger innovation in an even greater number of areas. This innovation is likely to manifest itself via a mixture of regulatory reforms, standardization, automation, a more efficient mix of labor, and changes in behavior. Here are six areas where change seems likely.
1. Legal Workforce
Virtually all sectors of the global economy have been forced to work remotely while nations grapple with brining the coronavirus under control. By the time this is over, companies and legal service professionals will have gained deep experience with how to do this effectively in just about every conceivable setting. We undoubtedly will see a return to offices when the virus clears, but the pendulum likely will not go back to where it once was.
With clients, corporate law departments, law firms, governments, etc. being more comfortable with remote work than in the past, it seems likely that the market for legal jobs will become less bound by geography. In other words, an employer in Chicago may now look to staff an opening nationally or even globally, as opposed to just locally.
The expanded acceptance of, and infrastructure for, remote work may also spark an increase in the gig economy for legal professionals. On the demand side of this equation, gig workers can be very attractive as the economy starts to recover but companies aren’t yet ready to take on long-term staffing commitments.
On the supply side, two factors are likely to drive this model. The first is the large number of laid off or furloughed workers who will be on the market. Second, this crisis hit right as the tail end of the baby boomers are in their late 50s and early 60s. These senior legal professionals have the skills and experience that will enable them to step into gig assignments with a limited ramp up.
Commerce is the lifeblood of the global economy and every purchase and sale of goods or services happens via a contract. Unfortunately, today’s standard practices around contracting are horribly inefficient, resulting in companies losing an average of over 9% of revenue annually to contract value leakage. See Teemu Marttinen, “Are you familiar with the concept of contract value leakage?,” Medium | DealSign, Sept 4, 2019. These practices, which include “gotcha terms” and extensive negotiations over things that have little commercial impact, stand to act as a drag on the economy as it tries to emerge from this crisis and to impede a law department’s ability to do more with less.
Past waves of innovation demonstrate that a better model exists: click accept agreements that allow contracting systems to be integrated seamlessly with store fronts, payment systems and fulfillment systems. A good example of this is your smart phone where you can select an app, sign a purchase/license agreement, make payment, and take delivery – all in less than one minute.
In order for this model to extend beyond business-to-consumer transactions where one party is completely dominant will require “industry standard” agreements that contain terms that are fair to both parties, eliminating the need for negotiation. Such agreements exist in areas of high volume transactions where multiple parties have bargaining power and can find themselves on either side of a transaction.
One example of this involves International Swaps and Derivatives Association (ISDA) transactions where financial institutions engage in derivatives transactions under a standard set of terms. Extending this more broadly requires a mechanism to make contract terms readily transparent so that buyers do not need to read pages of a contract and even more pages of incorporated policies and exhibits in order to know whether gotchas exist.
A variety of companies are already working on this problem via AI solutions and one-to-many solutions. Cf. Post 126 (discussing emergence of one-to-many legal solutions); Post 140 (same). It seems logical to think that the magnitude of the current downturn could help them get across the finish line.
3. Claims Resolution
The financial meltdown provides ample example of how disasters can create a flood of litigation. In that case we saw large volumes of largely repeatable claims arising out of subprime mortgages, etc. This time around the volume and diversity of claims seem likely to be even greater.
For example, a significant percentage of U.S. business are shut down, greatly reducing or even eliminating the revenue stream that they use to pay their bills to employees, suppliers and landlords. Each of these creditors, in turn, has their own set of bills that they now will have difficulty in paying. A prime example of this is the landlord who has a loan on the building leased to the business that the landlord now cannot pay, and the employee who has credit card debt, home mortgages, rent, etc. that he or she cannot pay. It seems inevitable that these events will trigger a raft of evictions, foreclosures, garnishments, bankruptcies, etc. that will overwhelm the traditional approach to claims resolution.
This pressure seems likely to trigger a wave of innovation to allow these claims to be handled far more efficiently. Examples of possible advancements include standardizing and automating claim filings, rules-based approaches to decision making, etc.
4. Access to Justice
Many of the claims resulting from the current downturn are likely to involve individuals without significant means who have lost their jobs, experience health problems, etc. Indeed, many economists predict that this segment of the population will be especially hard hit. These people will need assistance with not only defending themselves against their creditors but also seeking assistance for health care, housing, unemployment insurance, etc. Even before the downturn, these people had no real access to justice, with private attorneys being priced out of reach and the safety net of legal aid societies and public defenders being woefully inadequate. See Post 099 (discussing urgency around ODR); Post 091 (financial challenges affecting legal aid); Post 041 (cost of legal services increasing faster than CPI); Post 035 (data showing shrinking of PeopleLaw sector).
A variety of legal entrepreneurs, most notably LegalZoom, have tried to address this issue through a combination of technology and lower cost providers. Unauthorized practice of law rules, driven by state bar associations, however, have so far greatly limited the impact of these attempts. As a result, roughly 80% of legal services today get delivered by JDs while less than 10% of medical services get delivered by MDs or DOs. See Post 140 (contrasting medical and legal sectors).
The coming tsunami of claims, and the economic consequences of not handling them efficiently, has the potential to drive another wave of meaningful change. Simply hiring a few more legal aid attorneys won’t solve the problem and the government likely won’t have the budget to do so. Real regulatory reform that embraces automation, lower-cost legal professionals, and standardization seems like our best bet.
The impending wave of claims threatens to swamp not only the parties to the claims and their legal representatives, but also the tribunals who must adjudicate them. In all likelihood, the state and federal governments sponsoring these institutions will be cash strapped due to the decline in tax revenues and unable to provide much in the way of incremental funding. This creates a situation that is ripe for innovation.
Over the past decade, courts have been moving steadily toward putting standard forms on-line, enabling claimants to create standardized filings that are complete and easier to handle. It seems logical that this approach will continue and that we may even see rules-based decisions.
6. Legal Education
Law school education historically has been delivered entirely in person. The cost structure of this approach has resulted in high tuition levels and soaring student debt loads. Even if law school faculties were inclined to evolve the model radically, ABA rules require that 64 credit hours (of 83 minimum for a JD degree) to be taught using “courses that require attendance in regularly scheduled classroom sessions or direct faculty instruction,” see ABA Standard 311, albeit a change in 2018 permitted up to one-third of required credit hours potentially taught via distance learning. Martin Pritikin, “ABA Online Credit Increase A Step In The Right Direction,” Law360, Sept 4, 2018.
The coronavirus changed all of this overnight. With law schools subject to shut down orders, they have moved all of their curriculum to a distance learning model. Schools have no choice but to make this work. As schools, students, faculties and employers see how this model can work it seems likely that pressure will grow for distance learning to be incorporated into the standard menu of offerings as a means of containing cost if nothing else. The ABA limits on online credits seem likely to erode.
In-person classes are not the only thing that is likely to change. All indications are that the traditional in-person bar exams will not be happening this July. A committee of the ABA has come up with a set of proposed alternatives ranging from waiving the exam entirely to moving it to an online exam. Long-term change here seems likely as well, with this change having the potential to seep into licensing requirements more broadly.
The dot com implosion of the early 2000s and the financial meltdown of 2008 both triggered important waves of innovation in the delivery of legal services. The likely economic disruption of the current coronavirus calamity dwarfs either of those prior events. It seems logical to predict that businesses will respond to the current downturn as they did in the past by cutting costs to conserve cash, subjecting law departments to the now-familiar pattern of having to do more with less, with pressure increasing as the economy starts to recover.
Given the magnitude of the disruption we are facing, it seems almost inevitable that it will trigger a wave of innovation in the delivery of legal services that outpaces anything we have witnessed to date.
Bill Mooz is a co-founder of the Institute for the Future of Law Practice. Previously he headed up large legal teams at Sun Microsystems and VMware and founded and managed an office for Holland & Hart.